Public Debt and the Great Meltdown

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According to Paul Krugman, Germany’s finance minister, Wolfgang Schäuble, gave a speech today in which he said:

It’s actually undisputed among economists worldwide that one of the main causes – if not the main cause – of the turbulence – not just now, but already in 2008 – was excessive public debt everywhere in the world.

Say what? Krugman points out that he and Brad DeLong and Christina Romer, among others, dispute this, but I’d go much, much further. Two years ago I jotted down a list of all the common explanations for the financial meltdown that were then making the rounds, and out of 18 items there wasn’t a single one related to public debt. That doesn’t mean that literally no one was talking about this, but it does mean that it was uncommon enough that I hadn’t heard it. That makes it pretty uncommon.

Now, since then, there’s no question that Ken Rogoff and Carmen Reinhart have popularized the notion that public debt is bad news for economic recovery. But as far as I know, even they don’t suggest that it was the cause of the 2008 collapse. So what is Schäuble talking about? Well, Ambrose Evans-Pritchard reports on things that a few other Germans are saying today:

German President Christian Wulff has accused the European Central Bank of violating its treaty mandate with the mass purchase of southern European bonds. In a cannon shot across Europe’s bows, he warned that Germany is reaching bailout exhaustion and cannot allow its own democracy to be undermined by EU mayhem.

….The blistering attack follows equally harsh words by the Bundesbank in its monthly report. The bank slammed the ECB’s bond purchases and also warned that the EU’s broader bail-out machinery violates EU treaties and lacks “democratic legitimacy”.

….Chancellor Angela Merkel has struggled all this week to placate angry critics of her bailout policies within the Christian Democrat (CDU) party. Labour minister Ursula von der Leyen said countries that need rescues should be forced to put up their “gold reserves and industrial assets” as collateral, a sign that rising figures within the CDU are staking out eurosceptic positions as popular fury mounts.

….Mr Wulff said Germany’s public debt has reached 83pc of GDP and asked who will “rescue the rescuers?” as the dominoes keep falling. “We Germans mustn’t allow an inflated sense of the strength of the rescuers to take hold,” he said.

So: Germany is (understandably) unhappy about having to bail out the PIIGS and equally unhappy that this rescue will probably require them to substantially increase their own public debt. Politically, this means they need to badmouth public debt, so that’s what they’re doing. Schäuble is just taking a bit more dramatic license about it than the others. That will probably earn him points both at home and with the GOP’s deficit hawks here in America, but it doesn’t make him right. Debt was indeed a major cause of the 2008 financial collapse, but not the public variety. The private financial sector managed it all on its own.

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